A. Facts of the Case
1. A company which is a Government of India enterprise under
the Ministry of Steel, is an engineering, consultancy and contracting
organisation, offering a full range of services required for setting
up of projects from concept to commissioning including turnkey
execution. The company is a multi-disciplinary company having a
network of offices spread all over the country experienced in
handling consultancy assignments and Engineering, Procurement,
Construction and Commissioning (EPC) projects. As per the querist,
the company has played a significant role in the development and
the expansion of Indian industry. The company is an ISO: 9001:
2000 company and it is registered with international financial
institutions, like, World Bank, Asian Development Bank, African
Development Bank and has technological tie-ups with world leaders.
2. In the course of execution of turnkey projects, all jobs pertaining
to manufacturing and supply of plant and machinery are off-loaded
to various manufacturers since the company has no manufacturing
or assembly unit. Similarly, all site related activities, like, civil works,
erection, commissioning, etc., are also done by various contractors.
The company’s personnel provide engineering services (if required)
and supervision only.
3. According to the querist, while executing turnkey projects, the
company is following the provisions of Accounting Standard (AS)
7, ‘Construction Contracts’. The querist has further stated that as
per their understanding of AS 7, contract cost should comprise
costs that relate directly to the specific contract and costs that can
be allocated and / or specifically chargeable to any specific contract.
Costs which cannot be attributed to a contract activity or which
cannot be allocated to a contract and costs for which reimbursement
is not specified in the contract, are excluded from the costs of a
construction contract.
4. As per the querist, in case of the company, all direct costs
and costs attributable and allocated to a contract are considered
while estimating the cost to complete the project. Direct manpower
costs for manufacturing, civil works, erection, etc., for completion
of the project are included in the respective packages which are
ordered to various vendors. All other costs pertaining to the project
are judiciously considered while estimating the cost to complete
the project. However, the company does not consider payroll cost
of its own employees for estimation of the cost to complete the
project. Salaries, wages and other benefits of the employees are
time related fixed cost and have no relevance or relationship with
any project. It is payable to employees even if an employee remains
idle and no additional amount is payable to anybody even if he
works beyond working hours or during holidays. Also, the payroll
cost is not reimbursed by the clients. In view of the above, the
company considers that its own payroll cost is not a direct cost
and is a non-allocable cost, which may not be included in estimation
of cost to complete the project. Instead, the company charges pay
roll cost directly to the profit and loss account. The querist has
informed that this practice is being followed by the company over
the years and the same is also disclosed in the company’s Notes
to Accounts.
B. Query
5. The querist has sought the opinion of the Expert Advisory
Committee on the issue as to whether the practice of the exclusion
of time related fixed payroll cost while estimating the cost to
complete a contract results in a deviation from AS 7.
C. Points considered by the Committee
6. The Committee notes paragraphs 15, 17, 18 and 19 of AS 7
which state as follows:
“15. Contract costs should comprise:
(a) costs that relate directly to the specific contract;
(b) costs that are attributable to contract activity in
general and can be allocated to the contract;
and
(c) such other costs as are specifically chargeable
to the customer under the terms of the contract.”
“17. Costs that may be attributable to contract activity in
general and can be allocated to specific contracts include:
(a) insurance;
(b) costs of design and technical assistance that is not
directly related to a specific contract; and
(c) construction overheads.
Such costs are allocated using methods that are systematic
and rational and are applied consistently to all costs having
similar characteristics. The allocation is based on the normal
level of construction activity. Construction overheads include
costs such as the preparation and processing of construction
personnel payroll. Costs that may be attributable to contract
activity in general and can be allocated to specific contracts
also include borrowing costs as per Accounting Standard (AS)
16, Borrowing Costs.”
“18. Costs that are specifically chargeable to the customer
under the terms of the contract may include some general
administration costs and development costs for which
reimbursement is specified in the terms of the contract.”
“19. Costs that cannot be attributed to contract activity or
cannot be allocated to a contract are excluded from the costs
of a construction contract. Such costs include:
(a) general administration costs for which
reimbursement is not specified in the contract;
(b) selling costs;
(c) research and development costs for which
reimbursement is not specified in the contract; and
(d) depreciation of idle plant and equipment that is not
used on a particular contract.”
From the paragraphs of AS 7 reproduced above, the Committee is
of the view that the payroll cost of the employees of the company
should be included in the contract costs if these can be attributed
to contract activity in general and can be allocated to specific
contracts.
7. The Committee notes that the querist has stated in paragraph
4 of the Facts of the Case that the company considers that its own
payroll cost is not a direct cost and is a non-allocable cost and has
no relevance or relationship with any project. However, the
Committee also notes that in paragraph 2 of the Facts of the
Case, the querist has stated that the company’s personnel provide
engineering services, if required and supervision to the turnkey
projects. The Committee is of the view that the services rendered
by such employees forms part of the various activities necessary
to execute and complete the contracts undertaken by the company.
Thus, the payroll cost of such employees is part of the cost that is
necessary to incur to complete the contracts of the company.
Accordingly, the Committee is of the view that the payroll cost of
such employees is attributable to the contract activity and should
form part of the contract cost, as allocated to various contracts on
the basis of a systematic and rational method, such as, time spent
on the various contracts. The Committee further notes that the
querist has not elaborated upon the nature of jobs performed by
other employees of the company. Therefore, the Committee is
unable to comment upon the inclusion/non-inclusion of the payroll
cost of other employees in the contract costs. However, the
Committee is of the view that payroll cost of all those employees
whose activities are attributable to the contract activity should be
allocated on a systematic and rational basis to various contracts.
However, according to paragraphs 18 and 19 of AS 7, which are
reproduced above, general administration costs should not be
included in the contract cost.
D. Opinion
8. On the basis of the above, the Committee is of the opinion
that the payroll cost of the employees rendering services that are
necessary to complete the contract are costs that are attributable
to the contract activity in general and should be included in the
cost to complete a contract allocated on a systematic and rational
basis, such as, the time spent on the various contracts. The payroll
cost of other employees rendering general administrative services
should, however, be charged directly to the profit and loss account.
1Opinion finalised by the Committee on 13.11.2007. |